Investment Weather Forecast: global bonds continue to find support

Gareth Isaac discusses why the outlook for global bonds rests on central bank monetary policy and which areas of the market could come under pressure in the coming months.


Gareth Isaac

Gareth Isaac

Global bonds braced for Fed lift off

The outlook for the global bond markets remains constructive in the near-term.

Although interest rates are likely to rise in the US at some point this year, the US Federal Reserve (Fed) will only move gradually, and rates will then likely rise to levels seen in previous tightening cycles.

The reason that they can be so measured, despite a marked improvement in the outlook for the US economy, is that inflation remains very low by historical standards, and we expect inflationary pressures to remain benign for the foreseeable future.

Elsewhere in the world, interest rates in major economies are likely to remain on hold, which will support bond prices.

The market will also be supported by unconventional central bank measures such as quantitative easing.

The European Central Bank has begun a long-term bond purchase programme, as has Japan, and these measures will keep downward pressure on bond yields.

US monetary policy

A major concern is that the Fed, in its desire to be slow and gradual, will leave monetary policy too loose and medium-term inflationary pressures will build.

US unemployment has fallen sharply over recent years, and we’re starting to see the signs of improving wage growth.

Increases in real wages will drive consumption and may push up inflation once the base effects from the commodity decline pass through.

Monetary policy works with a lag, and if the Fed waits until it sees signs of inflationary pressures building, it may need to hike more aggressively than the market expects, causing some adverse market movements.

Another concern is that debt levels among European countries have risen to unsustainable levels.

Much has been commented on Greece, but many other countries have debt levels that are too high, and when the next crisis or recession arises, then sustainability of those countries will be called into question.